From GST to deficit rains: Positive outlook apart, India is nowhere near a ratings upgrade

India is no where near getting a rating upgrade though ratings agencies have endorsed the Narendra Modi government’s policies as the country still straddled with various structural issues, experts have said. A likelihood of below normal rainfall will only make matters worse.

According to a report by Religare, India Ratings has highlighted major issues that are likely to hinder a faster ratings upgrade for the economy.

India Ratings is a subsidiary of global major Fitch Ratings, which had recently estimated the country’s GDP growth at 8 percent in 2015-16. The higher growth estimate by Fitch coincided with Moody’s upgrade of its outlook for India.

Both the actions were seen as an approval of the Modi government’s economic policies. However, for those who thought a ratings upgrade – the country has been languishing in a near-junk rating for the last four years – is just around the corner, this should come as a warning that it is just not so.

According to Religare, India Ratings has told the brokerage firm that there are several impediments for the country to witness a ratings upgrade.

First and foremost, it has said that any such action is possible only after India brings about a structural improvement in tax receipts and its composition.

“Key areas of concern include a stagnant tax-to-GDP ratio over the last decade, a low share of indirect taxes at 45% and the decline in excise duty as a percent of manufacturing GDP to 13 percent from 24% in FY04,” the note said.

An look at India’s tax-to-GDP ratio shows that the figure was stuck in the 9.64-11.89 percent range in the last 10 years. As far as the share of indirect taxes is concerned, in developed countries it stands at 55 percent, way higher than India’s.

The country needs to increase the share of indirect taxes to align it with the developed nations as there is no scope for an increase in direct taxes now since such a move will further dent the demand scenario.

The low tax-to-GDP ratio in India is because tax collection has been growing at a slower rate than the GDP. What this means is that India’s tax collection is not efficient enough. So in order to increase the ratio, the government has to take steps to improve the efficiency levels.

“GST legislation though much diluted from earlier version is still far better than the current taxation system and will improve indirect tax collections if implemented,” says the report.

In other words, pushing through the much delayed GST, which seeks to streamline Indian tax system, will hasten the ratings upgrade. However, despite the government making some headway in the implementation of the bill from 1 April 2016, there is still a lack of consensus.

In the Lok Sabha today, the Congress and BJD have demanded that the bill should be send to the house panel. However, finance minister Arun Jaitley has warned the government will not be able to meet the deadline is it is send to the House Panel.

Second issue highlighted by the ratings agency is the inflation. According to India Ratings, CPI inflation is more a supply-side issue and so RBI action will have limited impact in controlling it.

The central bank may be able to rein in the demand to some extent. The government’s steps like curbing hoarding and pilferage and plugging the leakage can also help. But these measures are all short term in nature. The government is yet to take long term measures to improve the productivity, which has remained stagnant for the last five years.

In a year when rains are expected to be below normal, there are chances of inflation spiralling out of control. Such an eventuality will further reduce the chances of an early ratings upgrade.

Thirdly, the private sector is unlikely to make investments for anoyther 12-18 months. In this context, the government itself will have to be the first mover to kick start the investment cycle. India Ratings sees the marginal increase in the fiscal deficit target to 3.9 percent of GDP as a good move by the government.

But the bigger question is where will the government find the funds for pushing a higher investment. Already, direct tax collection in 2014-15 has fallen 14 percent short of target at around Rs 6,96,200 crore. With the corporate earnings still lagging, one cannot expect better tax buoyancy this year. This is likely to tie the government in knots and push the economy into a vicious cycle.

Taking all this into account, a ratings upgrade is unlikely in the near future.